Understanding Income Statements in Accounting
Dive into the world of income statements in accounting to grasp the purpose, layout, and calculations involved. Explore key terms like revenue, purchases, inventory, and cost of sales. Enhance your ability to analyze business performance and profitability ratios by evaluating a sample income statement. By the end of this tutorial, you will have a solid foundation in interpreting and creating income statements for businesses.
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A Level Accounting Income Statements Please turn on the slide show Application Evaluation Knowledge Analysis
By the end of these tasks... You will be able to define and explain the purpose of an income statement You will know the layout of an income statement and what to include within the statement. OPTIC You will be able to make calculations to include in an income statement Challenge You will be able to calculate profitability ratios to analyse business performance Application Evaluation Knowledge Analysis
Introduction to Income Statements The main activity of a trading business is to buy goods at one price and sell the same goods at a higher price. The difference between the two prices represents a profit known as gross profit. The gross profit for each item is totalled to show one figure. At the end of the financial year, the business needs to produce an income statement, showing the trading of the business and showing the gross profit for the year. Application Evaluation Knowledge Analysis
As a student, you need to know the layout of the income statement The layout of the income statement is as follows: Application Evaluation Knowledge Analysis
Income Statement for Wyvern Wholesalers For the Year Ended 31 December 20-1 Sales (Revenue) 250,000 Less Sales Returns 5,400 Net Revenue (A) 244,600 See Slide 8 for formulae to calculate A B C D Opening Inventory (1 January 20-1) 12,350 Purchases 156,000 Carriage In - Less Purchase Returns 7,200 Net Purchases (B) 148,800 161,150 Less Closing Inventory (31 December 20-1 16,300 Cost of Sales (C) 144,850 Gross Profit (D) 99,750 Application Evaluation Knowledge Analysis
Key Terms Revenue money coming into the business from sales Purchases only include items that the business trades with; sells on. Inventory these are the goods that the business has in stock Cost of Sales cost to the business of the goods which have been sold in the financial year Carriage in the expense to the business of having purchases delivered Application Evaluation Knowledge Analysis
With viewing slide 5, certain calculations need to be carried out. To calculate A B C D see the next slide Application Evaluation Knowledge Analysis
Formulae Cost of Sales (C) Opening inventory + Purchases + Carriage in - Purchase Returns - Closing inventory = Cost of Sales Gross Profit (D) Revenue - Sales Returns = Net Revenue - Cost of Sales = Gross Profit or Loss Net Revenue or Turnover (A) Revenue (Sales) - Sales Returns = Net Revenue Net Purchases (B) Purchases + Carriage In - Purchase Returns = Net Purchases Application Evaluation Knowledge Analysis
Profit for the Year Obviously, businesses have many other costs other than buying goods to sell on. They need premises, electricity, salaries and insurance, etc. We now need to include these expenses on the income statement by subtracting them from the gross profit Application Evaluation Knowledge Analysis
Income Statement for Wyvern Wholesalers For the Year Ended 31 December 20-1 Total Expenses = 3,700 + 46,000 + 3,000 + 2,000 + 4,700 = 59,400 Gross Profit 99,750 Add discount Received 2,500 102,250 Less Expenses Discount allowed 3,700 Salaries 46,000 Electricity and Gas 3,000 Business Rent and Rates 2,000 102,250 total expenses 59,400 = profit for the year of 42,850 Sundry Items 4,700 59,400 Profit for the Year 42,850 Application Evaluation Knowledge Analysis
Example The following 3 slides show you how to create an income statement Application Evaluation Knowledge Analysis
The following information has been extracted from the business accounts on Matthew Lloyd from his first year of trading which ended on 31st December 2018. (** there is no opening inventory! **) Purchases 94 350 Revenue (Sales) 125 890 Inventory at 31st December 2018 (Closing Inventory) 5 950 5 950 Office Rent 4 850 Heating and Lighting 2 120 Wages and Salaries 10 350 Office Equipment 8 500 You are to prepare the Income Statement of Matthew Lloyd for the year ended 31st December 2018. Application Evaluation Knowledge Analysis
Steps to complete the Income Statement 1. Include the title showing the business name, statement name and date the financial statement ends (as slide 5) 2. Layout the income statement as shown on slides 5 and 10 3. Insert the figures (from slide 12) 4. Calculate cost of sales (from slide 8) 5. Calculate gross profit (from slide 8) 6. Add up total expenses (from slide 10) 7. Calculate profit for the year (from slide 10) Application Evaluation Knowledge Analysis
Answer - Checkpoint MATTHEW LLOYD INCOME STATEMENT FOR YEAR ENDED 31 DECEMBER 2018 Revenue 125,890 Opening Inventory - Purchases 94,350 Less Closing Inventory 5,950 Cost of Sales 88,400 Gross Profit 37,490 Less Expenses: Office Rent 4,850 Heating and Lighting 2,120 Wages and Salaries 10,350 17,320 Profit for the Year 20,170 Application Evaluation Knowledge Analysis
Now go to the SIL document and complete tasks 2 3 and 4 Application Evaluation Knowledge Analysis
Profitability Ratios A business uses the income statement to analyse its progress by comparing its performance from one year to the last. It can then see whether it is improving, by making more profit, or deteriorating by making less profit. This analysis helps the business to make decisions. It does this by calculating some ratios Application Evaluation Knowledge Analysis
Profitability Ratios Gross Profit Margin Gross Profit Mark Up Gross Profit x 100 Revenue Gross Profit x 100 Cost of Sales The higher the percentage the better A margin of 25% means for every 100 of purchases made, the business makes 25 gross profit Expenses in relation to Revenue Profit in relation to Revenue Expenses x 100 Revenue Profit for the Year x 100 Revenue The higher the better Application Evaluation Knowledge Analysis
Using our Example Matthew Lloyd Gross Profit Margin Gross Profit x 100 = Revenue 37,490 x 100 = 29.78% 125,890 This shows that for every 1 of revenue coming into the business, it make over 29p in gross profit The higher the figure the better Application Evaluation Knowledge Analysis
Gross Profit Mark Up Gross Profit x 100 = 37,490 x 100 = 42% Cost of Sales 88,400 A margin of 42% means for every 100 of purchases made, the business makes 42 gross profit Application Evaluation Knowledge Analysis
Expenses in relation to Revenue Expenses x 100 Revenue 17,320 x 100 = 14% 125,890 For every 1 of revenue, the business spends 14p on expenses Application Evaluation Knowledge Analysis
Profit in relation to Revenue Profit for the Year x 100 Revenue 20,170 x 100 = 16% 125,890 Shows the percentage of profit made after all expenses have been considered Application Evaluation Knowledge Analysis
Now complete the last task on the SIL sheet Bring your work for tasks on sources of finance and income statements, tasks 2, 3, 4 and 6 to college on your first day Good luck and see you soon The Accounting Team at New College Learning Trust Application Evaluation Knowledge Analysis
